GARP is short for “growth at a reasonable price.” Different investors have different definitions for what is and isn’t a GARP stock. I have my own definition, and Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) fits it, and rather nicely I might add.
I consider a stock to be a growth stock if it is growing earnings at a rate of 15% or higher from one year to the next, ideally over a five-year annualized time frame. Also, I consider a reasonable price for a non-growth stock to be anything trading with a PEG ratio of 1.0 or less. If a stock, any stock, trades at a PEG ratio of 1.0 or less, I consider it to be a value stock.
Thus, if I am able to find a growth stock that trades at a PEG ratio of 1.0 or less, it is essentially the value version of a growth stock, or a GARP stock. These stocks are few and far between. But if you can find them, you’re getting a terrific value.
There are also other considerations in terms of valuation. I subtract the company’s net cash position from its market cap to determine its P/E ratio. I also permit a 10% premium to earnings growth expectations for each of the following: excessive net cash position, exceptional free cash flow and world-class brand name.
GOOGL Stock: Growth and Value
GOOGL has all of these elements, plus it’s a pretty darn good business, considering it basically has a monopoly over search engine advertising.
Mind you, should digital advertising ever completely blow up, Alphabet stock could find itself in a real pickle. However, considering that the ad spend during the financial crisis went down a fair amount, but not so much as to destroy businesses like Alphabet, I don’t see that happening.
Another, admittedly very small, risk to GOOGL stock is the increasing outcry from political conservatives regarding the company’s alleged, but apparent, leftist political bias. This bias has shown up in search results, via internal memos that have been leaked to the press, and in a recent lawsuit against the company.
Putting all that aside, let’s take a look at why GOOGL stock makes for a great GARP stock.
GOOGL stock presently has a market cap of $810 billion. It has a net cash position of $105 billion, taking its net cash market cap down to $705 billion. Alphabet stock earned $22 billion last year. Thus, it has a base P/E ratio of 32.
Analysts project annualized earnings growth over the next five years of 25%. Thus, I would be willing to pay, under normal circumstances, 25 times net income for the stock.
However, GOOGL stock gets 10% price premiums because it does in fact have significant cash on hand, outstanding free cash flow and a world-class brand name. That brings the price I’d be willing to pay up to 32.5 times net income. And there we have it, a PEG ratio for a growth stock of 1.0.
It’s hard to believe that Google’s search engine has become this dominant over time, but it has. And now you have a fantastic stock for your long-term portfolio.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance, and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
